Insurance Terms and Related Concepts
Core vocabulary
Surplus lines questions test whether you can separate the cause of loss from the condition that makes loss more likely or more severe. Risk is the chance of loss; peril is the cause of loss (fire, wind, theft); hazard is a condition that increases the chance or severity of loss. Physical hazards include oily rags or faulty wiring; moral hazard involves dishonesty; morale hazard is carelessness because insurance exists. Pure risk is loss-only and insurable; speculative risk involves gain or loss and is not.
Indemnity and insurable interest
Indemnity restores the insured to approximately the pre-loss financial position, no better. Insurable interest is a financial stake in the loss; in property it must exist at the time of loss, while in life insurance it must exist at policy inception. Actual cash value is typically replacement cost minus depreciation; replacement cost pays new-for-old without depreciation. Coinsurance is a property-proportional requirement, not the health-insurance copay concept.
Traps
- Calling fire a hazard instead of a peril.
- Treating reinsurance as surplus lines; reinsurance is insurer-to-insurer risk transfer, while surplus lines is placement with a non-admitted insurer.
- Confusing ACV with replacement cost.
- Assuming all risk is insurable.
Worked example
A warehouse stores oily rags near a heater. The peril is fire; the oily rags are a physical hazard because they increase the likelihood and severity of fire. If a fire destroys a $10,000 machine with $4,000 depreciation, ACV pays roughly $6,000, while replacement cost pays the cost to replace, subject to limits.
Rule of thumb: peril = what causes the loss; hazard = what makes that peril more likely or worse.